Shearson Chiefs Say Hard Times Mean Leaner, More Efficient Industry

NEW YORK — Eighteen months from now, the securities industry will have emerged from hard times. But in the interim, hundreds of laid-off workers will leave the industry for jobs at foreign commercial banks and investment banks, takeover activity will slow after three years of unstifled growth, the retail brokerage business will lie fallow, a new financial product will emerge as an alternative to "junk bond" financing and one or more independent securities firms will either diversify through acquisition or be acquired themselves.

This scenario was painted Thursday by the chairmen of Shearson Lehman Bros.' investment banking group during a wide-ranging discussion with financial reporters.

The co-chairmen, Peter J. Solomon and Sherman R. Lewis, also said they have changed their employee-review process so the "mismanagement" of human resources that led to Wall Street's serious overstaffing before the inevitable downturn won't recur.

They portrayed the process of selecting employees to be laid off as a result of Shearson's recent acquisition of E. F. Hutton Group as a grueling task that was done only after "very extensive interviews" with borderline people.

And they said Shearson is "amazed" that it won Hutton without a fight from Merrill Lynch, still the nation's largest securities firm by some measures.

Neither man questions the wisdom of buying a brokerage amid turmoil in the financial markets. But they do predict tough times ahead.

"I happen to think we're going to have tough times in the next year (or) year and a half," Lewis said. "We will come through it OK because we're so diverse . . . but those that aren't will be adversely affected."

He predicted that a securities industry slowdown will be particularly tough on Prudential-Bache and Paine Webber, because they are heavily dependent upon the retail brokerage business, and on Morgan Stanley and First Boston, because they rely heavily on the mergers and acquisitions business.

The executives also predicted that the industry's ensuing difficulties will make securities firms prime takeover targets--along with food, cable television and cellular telephone companies--and that Morgan Stanley is particularly ripe for a takeover bid because its shares have taken a beating and because of its specialization in mergers and acquisitions, or M&A.

Shearson Lehman also is gearing up for changes in its business mix.

"You will see us pouring more people into merchant banking and into M&A," Solomon said. "We will be building up those areas very strongly."

"In junk debt, the issue (of most importance) is the creation of the packaging," Solomon said. "We weren't happy with what we were doing with the packaging, with getting the right combination of securities."

He expects Shearson's capabilities in packaging such subordinated debt to be greatly improved by the time junk bonds break out of the slump they have been in since the stock market crashed on Oct. 19.

"Right now, there is no market," he said. "(The) junk (bond market) even for Drexel is awful."

The controversial junk bond market may never return to its glory, he concedes, which is why he said Stern is trying to design Wall Street's next marvel of a financial product.

"We have to have the junk business back or invent something else that emulates it if we are to get the M&A business back" after the slowdown that he expects.

Solomon's scenario is this: The mergers and acquisitions business will continue at its record-setting pace through the first quarter, fueled largely by money from British, French and West German investors. A sharp slowdown will follow after the first quarter--the delayed result of the junk bond slump and of investment banks' post-crash hesitancy to make so-called bridge loans--those that provide a financial bridge between the conclusion of a deal and the arranging of permanent financing.

"Everybody, including ourselves, is more cautious about bridge financing" since Oct. 19, Solomon said. "That will certainly slow down takeovers."

Bridge financing is the best-known aspect of merchant banking, in which firms put their own capital on the line in order to win mergers and acquisitions business.

It is one business at which Shearson hasn't excelled, Solomon now acknowledges.

"We were getting upset about . . . missing deals. We would come in at $40 and the deal would go at $47.50. We went through a lot of self-doubt about our mispricing of deals."

But when the stock market collapsed, exposing several merchant-banked deals as overpriced, "we realized that we were as lucky as hell" to have lost out on them, he said.